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Fixed rates and protectionism, 2009 edition

October 26, 2009 12:47 pmOctober 26, 2009 12:47 pm

Barry Eichengreen and Doug Irwin have a new paper challenging the conventional wisdom about protectionism in the 1930s. It wasn’t about economic ignorance, or at least
not about microeconomics; it was about the attempt to escape the “golden fetters” of the exchange rate. The most protectionist countries were those that tried to keep their peg to gold; and as they
say,

This suggests that trade protection in the 1930s was less an instance of special interest politics run amok than second-best macroeconomic policy management when monetary and fiscal policies were constrained.

Well, as it happens, I’m right in the middle of a contemporary example. I’m blogging from Quito, Ecuador. Ecuador is dollarized — no currency of its own, just US dollars. And this leaves the country
with very limited room for maneuver during the current crisis. And here’s what happened:

In January 2009 Ecuador announced a series of stiff import restrictions on 630 tariff lines, affecting 8.7 percent of its ‘tariff universe’ and 23 percent of the volume of imports. Duties were raised
on 369 tariff lines and quota restrictions imposed on 271 others for a one-year period. They cover products ranging from processed foods and shoes to cars, mobile phones and sunglasses, as well as many other
goods that can be manufactured in Ecuador.

Ecuador insisted that the measures it proposed were necessary to balance its widening current account deficit. GATT Article XVIII allows developing countries to impose temporary import controls to “forestall
the imminent threat of, or to stop, a serious decline in its monetary reserves; or, in the case of [a Member] with very low monetary reserves, to achieve a reasonable rate of increase in its reserves.”

Can you really say that Ecuador was wrong to do this, given its lack of other policy tools? At the very least, you have to say that there’s a pretty good second-best case for the policy — and the WTO has
reached a compromise allowing Ecuador to keep the measures in place at least for now.

Of course, Ecuador should be getting considerable relief from the falling dollar … except that its main competitive problem comes from China, which has been following the dollar down.

Anyway, no deep moral here, except to say that the problems that faced nations on the gold-standard in the 1930s are being replicated in countries pegged to the euro or the dollar today.

Is there that much of a difference between this or having your currency inflate or deflate in response to current account pluses or minuses. I think this way is actually more fair, for if there were only one currency
worldwide, no country would have a greater advantage or disadvantage – every country would live or die (or at least the standard of living of it’s inhabitants) based upon their relative productivity.
And what’s wrong with that? If there are mitigating circumstances to consider (historical or otherwise), that is where development aid would apply, without any distorting effects of currency volatility.

So does this mean the euro was a very bad idea for Europe? Is this part of the foundation of an argument against the hypothetical “amero”? Or is this just the down side of a tradeoff for currencies
like the euro?

It is also a great example for the United States (of the past twenty years) to learn from. We were importing such low cost merch from the developing world that we needed to keep rates low just to stave off deflation.
But we may have forgone the excessive leverage of the Greenspan era if, instead, we held higher rates in combination with a — heaven forbid — tariff regime.

Protectionism is the only way the global economy will recover and we have no time to lose.

THE GRIMES ECONOMIC RECOVERY PLAN

The Grimes Plan will restart global commerce with a graduated surcharge over 48 months (possibly longer) on all manufactured imports and out-sourced services. This plan will have little effect on trade with economies
that pay livable wages by most G-20 standards.

This surcharge is a two way street. All countries may and should impose a surcharge: i.e., China, India, et al can impose an equal surcharge on all imports, allowing for an orderly transition and global stabilization
as international commerce is redefined.

The fulcrum is this: trade imbalance. We import far more than we export. The surcharge on all imports will begin at 5% to 10% for the first 12 months, with a 1% monthly increase over the next 36 months. The surcharge
will offset most of the direct expense of the Grimes Plan.

General Motors, Ford and Cerberus* can still manufacture cars in foreign countries. Now they’ll just have to produce what the indigenous labor markets can afford to purchase. This applies to all industries,
not just automotive.

Foreign companies (such as Toyota) are more than welcome to sell in the USA, as long as they manufacture their products in the USA and pay livable wages.

China and other slave labor markets sulppying the likes of Wal-Mart will have to concentrate on manufacturing products for internal consumption that their indigenous labor force can afford to purchase.

Every sovereign nation has to develop its own economy with manufacturing dependent on internal consumption and the United States is no exception.

Over the years I’ve continually and relentlessly tried to find some political support to end the insanity, but to no avail. Unlike the fraudulent derivatives and sub-derivatives scams created by Wall Street
this will create global economic order, not chaos.

The logical extension of your argument is for ever smaller regional currencies, bounded only by the extent to which local governments can be credibly expected to make good on their debts; an interesting tension.

The transaction costs of changing currencies is dropping ever faster in a digital world; so perhaps currency Balkanization is something we’ll see in the not too distant future.

Personally, I think a local currency with fluctuating exchange rate to the dollar could do wonderful things for the eternally depressed economy of Rhode Island. I look forward to converting my entire savings to
Quahogs as soon as a more responsible and far sighted Governor is in office.

Professor Krugman ,
I am a student doing research on the Dollarization in Ecuador and I was wondering why inflation in Ecuador is so different from the United States even though it shares the same money supply?

A stable currency almost guarantees an unstable economy, as shocks in the international system then have to be balanced by changes in employment/production rather than by changes in the currency value.

I, for one, support a modified GRIMES ECONOMIC RECOVERY PLAN. That is, until a better one comes along.

The actual percentages may require adjustment, but the point is the same. We need to create domestic manufacturing to support internal consumption. The international suppliers would still provide products for U.S.
markets, but with a mild import duty on almost all products. The impact on specific categories, like autos, which may already have substantial duties, would be minimal, or not applied to certain categories.

The revenues, in the modified plan, would be used to invest in job-dense small manufacturng ventures of $1,000,000 or more capital requirement. the amount of money, in the tens of billions, that could be raised
from this simple measure is much more significant than the relatively minor inconvenience to importers.

The goal of the exercise would be to jump start the jobs market. After a couple of years the minuscule tariffs could be retired and the continuing job development funded by repayments from the businesses.

About ten years ago when I took up an issue of the Valuation of USD, Excessive Debt Loads both Public and Private and Trade Imbalances, people accused me heresy and I was nearly lynched for even talking about the
disasters to come!

You see Paul, Bretton Woods Agreement put the USD and as a result the US in the driver seat. That meant that the USD was equivalent or as good as Gold; however by early 1970s as the US kept its war efforts at high
levels, Nixon realized that it was not a sustainable policy, did away with the convertibility of the USD to Gold and made the US dollar “defacto replacement for Gold” and even better than Gold….

As for why the Gold Standard failed, there are numerous shaky theories as the one suggested by Brad De Long citing its limitations to support growth and deal with trade imbalances, etc. and that the floating exchange
regime is the right way to go….

So Paul, Brad’s theory did not work and the reasons appear to be the same as the old ones under the Gold Standard(s) that neither the central banks nor the FX markets are able or willing to have a fair and
efficient FX supermarket at all times….

In my view the US is suffering from the same mindset/syndrome post the collapse of the USSR that was prevalent in the UK in 1901 as The Queen Victoria passed away thinking that their economic and military might
will last forever….; and we all know what happened to that British pipe dream three decades later….

The solution remains the same as it was under the Gold Standard that the Central Bankers could “agree” to increase the price of Gold each year to accommodate for inflation and growth across the world
and in my view by going back to the teachings of Maynard Keynes with the spirit of the cooperation that was present at Bretton Woods, a G20 basket of currency with tight control of money supply in all jurisdictions
is what the Doctor has ordered once more!

There is a larger point, and that is that the right says they favor free trade, and then they do so much to decrease it indirectly. This includes:

1) Preventing/Decreasing compensation to the losers in free trade so that they don’t oppose it as vigorously — With free trade, with rare exception, the gainers gains outweigh the losers losses greatly,
but there are those who lose like some union employees, and by opposing generous retraining/education/aid money for them if they lose their jobs, they increase their opposition.

2) Shredding the social safety net

3) Shredding education and college aid — as the unskilled are more likely to lose jobs or pay as a result of free trade than the skilled.

4) Opposing universal health insurance

5) Opposing fiscal stimulus

All of these things from the Republicans decrease support for free trade and increase opposition to it. A Republican would never have been able to get NAFTA through congress.

As opposed to what just happened with an unstable currency where the shocks in the system didn’t result in high unemployment or a reduction in production. /snark

The point is with a stable currency you don’t receive the shocks because the money is at a stable value. When you cheapen the money by lowering interest rates artificially or printing more money than needed
is when you get an unstable production structure. It’s the collapse of those unstable production structures that give the international system the shocks we feel from time to time.